October could indeed turn out to be the month for scary surprises, but not for the reasons people think. While we’re distracted by the national circus we call the presidential election, there are economic threats building abroad.
If you think events in far-off lands can’t topple our markets, think back to 2008 when one U.S. bank, Washington Mutual, set off a chain reaction of events that brought the global banking system to its knees. The next banking crisis could originate in China and it’s shaping up to be a whopper.
Corsair Capital was down by about 3.5% net for the third quarter, bringing its year-to-date return to 13.3% net. Corsair Select lost 9.1% net, bringing its year-to-date performance to 15.3% net. The HFRI – EHI was down 0.5% for the third quarter but is up 11.5% year to date, while the S&P 500 returned 0.6% Read More
China’s Debt Bubble
In the U.S. it was the housing market; in China it’s commercial lending. China’s biggest companies are amassing a mountain of debt, something that sent that nation’s markets into a tailspin earlier this year. To give you an idea of the scale of corporate debt in China, it helps to realize that China’s GDP, the sum total of all its economic activity, is just slightly smaller than the GDP of the United States. But China’s corporate debt is 250 percent higher than its entire GDP. Wow, yes, that’s huge.
Trying to wrap your mind around the scale of Chinese corporate debt can be a challenge. Imagine a country larger than the United States—composed completely of corporate debt. The scale is so vast that we have a hard time visualizing the threat simply because it’s so big.
Rising Defaults Could be the Spark
The burning fuse on China’s giant corporate debt bomb is corporate defaults. Right now commercial loan defaults are running at just over five percent. That’s a bad number all by itself; a horrible, Godzilla-sized, run screaming for your life number of corporate defaults. Yet China analysts are expecting that rate to more than triple to anywhere from eleven to seventeen percent. It’s no exaggeration to say those are apocalyptic size numbers that, if they start to materialize, would send the Chinese stock market into freefall, bringing the rest of the global economy down with it.
The reason we’re all not already warming ourselves around trash can fires and picking through rich people’s trash for scraps of food is because China is not a free market. It has a managed economy, and the government is looking at a hefty bill for intervention. By some estimates China will have to come up with nearly $1.7 trillion dollars between now and 2020 just to cover bad corporate loans. Since it’s not like the Chinese government can take out a payday loan, that means they’ll simply print the cash to cover the bad debts.
Printing money sounds like fun and it’s how governments around the world pay bills. These days they don’t even need to fire up the printing presses. Someone clicks a computer mouse in a central bank and POOF! trillions in new cash appear as if by magic. But the downside to printing money is it dilutes the value of that nation’s currency, and the yuan is already at a six-year low. That means anyone holding China’s currency can look forward to their yuan holdings steadily losing value in the years ahead.
If it’s not entirely obvious by now, China’s corporate debt situation is a threat, not only to their economy, but to everyone who does business with them and, like it or not, we still do a lot of business with them. The amount of corporate debt we’re staring at in China makes the meltdown in 2008 look like a fight for the last cupcake at your kid’s birthday party.
If Chinese markets implode, it’s going to be sudden, it’s going to be massive and it’s going roll over our banking system like a wave.